The document summarizes the key points from the Financial Stability Review published on April 23, 2014. It identifies the main risks to Estonian financial stability as a worsening of risk assessments for Nordic economies and banks increasing funding and liquidity risks, and a deterioration in the external environment weakening economic growth in Estonia and worsening bank loan quality. Rapid growth in real estate prices is also highlighted as a risk that could affect household and business finances and build up risks in the financial system.

1. Financial Stability Review
23.04.2014

2. Key points
• Development and current state of the Estonian Financial
Sector
• Additional topics covered in the Review: savings and loan
associations, instant loans, real estate prices
• An assessment of the main risks affecting Estonian
financial stability
2

3. Economic activity in the euro area has increased, but
growth remains modest
Source: Eurostat
-15%
-10%
-5%
0%
5%
-3%
-2%
-1%
0%
1%
2005 2006 2007 2008 2009 2010 2011 2012 2013
GDP real quarterly growth in the euro area and Estonia
euroala (vasak telg) Eesti (parem telg)
Uneven development in emerging markets could raise tension
in financial markets and weaken the outlook for growth
3
euro area (left scale) Estonia (right scale)

4. Sources: Finnish customs board, national statistical offices
Any worsening of the Ukraine crisis poses a serious
risk of deterioration in the external environment for
Estonia
Trade with Russia is also important for our main trading partners
4
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
Share of exports going to Russia in 2013
Estonia Latvia Lithuania Finland Sweden

5. The slowing of Estonian economic growth reduced
the profitability of companies, but payment
behaviour and finances continued to improve
Sources: Krediidiinfo, Eesti Pank
5
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
Q1-2 Q3-4 Q1-2 Q3-4 Q1-2 Q3-4 Q1-2 Q3-4 Q1-2 Q3-4 Q1-2 Q3-4 Q1-2 Q3-4
2007 2008 2009 2010 2011 2012 2013
Payment behaviour of companies
overdue loans as a share of the portfolio
share of companies with tax debts
share of companies with payment difficulties

6. Wage pressures may start to affect the ability of
companies to repay loans
6
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25% 2005
2006
2007
2008
2009
2010
2011
2012
2013
Annual growth in corporate profits and gross monthly wages
average gross monthly wages (left scale) company profits (right scale)

7. Overdue loans are forecast to continue
falling as a share of the loan portfolio
If the external environment were to deteriorate, overdue
loans would grow less than during the last downturn
7
0%
1%
2%
3%
4%
5%
6%
7%
8%
2008 2009 2010 2011 2012 2013 2014 2015
Loans overdue by more than 60 days as a ratio of the loan portfolio
actual base scenario 5 pp 10 pp 15 pp

8. Household indebtedness and housing prices have
continued to rise in Sweden
Sources: statistical offices, Valueguard
Swedish banks are largely funded through financial markets,
and so their funding can be rather fragile
8
100
120
140
160
180
200
220 2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Indices of house prices in Sweden (January 2005=100)
Sweden Stockholm flats Stockholm houses

9. Capital indicators for parent banking groups have
been supported by good profitability and low volumes
of problem loans
Source: public reports of banks
* based on Basel III
9
0%
5%
10%
15%
20%
25% 2010
2011
2012
2013
2010
2011
2012
2013
2010
2011
2012
2013*
2010
2011
2012
2013*
Danske Nordea SEB Swedbank
Capital adequacy of Nordic parent banking groups
total capital ratio Tier 1 Core Tier 1 Tier I Basel II according to transition rules

10. Banks operating in Estonia are using fewer funds
from parent banks to finance lending
Parent banks play an important role in centralised liquidity and capital
management
10
0
5
10
15
20
0%
50%
100%
150%
200%
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
EURbillion
Loans and deposits
loan to deposit ratio (left scale) volume of loans (right scale)
volume of deposits (right scale)

11. The profitability of the banks has been helped by low
funding costs, by the recording of earlier loan write-
downs as profit and by dividends from subsidiaries
11
-4%
-3%
-2%
-1%
0%
1%
2%
3%
-1,500
-1,000
-500
0
500
1,000
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
EURmillion Components of bank profitability
write-downs expenses
other income income from fees and services
net interest income return on assets (right scale)

12. Loan and deposit interest rates in Estonia are lower than
in most European countries
Source: European Central Bank
12
0%
1%
2%
3%
4%
5%
6%
CY
PT
SK
FR
IT
SI
BE
NL
MT
LV
ES
IE
GR
EE
DE
AT
FI
LU
euroarea
LT
SE
DK
Average interest rates for loans and deposits for households in February 2014
housing loans household deposits of up to one year
-3%
-2%
-1%
0%
1%
CY
PT
SK
FR
IT
SI
BE
NL
MT
LV
ES
IE
GR
EE
DE
AT
FI
LU
euroarea
LT
SE
DK
Net write-downs by banks as a ratio to total assets in Q1-Q2 2013

13. The level and quality of capitalisation in the
Estonian banking sector are very good
13
5%
10%
15%
20%
25%
2008 2009 2010 2011 2012 2013
Capital and leverage ratios
common equity tier 1 capital ratio capital adequacy ratio leverage ratio

14. There are more problems with loan repayments in
the instant loan market than with the much larger
volume of bank loans
Sources: Eesti Pank, commercial register, Ministry of Economic Affairs and Communications14
0
100
200
300
400
500
600
700
800
2010 2011 2012
EURmillion
Consumer loans issued by instant loan
companies and banks
assets of instant loan companies consumer loans issued by banks
0
10
20
30
40
50
60
70
80
90
100
estimated volume
of problem loans
at instant loan
companies (2012)
instant loan assets
passed on to debt
collection
companies or
subject to court
proceedings (2013)
household
consumer loans
from commercial
banks overdue by
more than 60 days
(2013)
household
mortgage loans
from commercial
banks overdue by
more than 60 days
(2013)
EURmillion
Instant loans subject to claims by debt collection
companies or to court proceedings

15. Low interest rates meant that household deposits with
savings and loan associations increased
• Unlike bank deposits, deposits in SLAs are not covered by the deposit guarantee scheme
and income tax must be paid on the deposit interest earned
• There is no supervision of SLAs, the members themselves are responsible for the sound
operation of SLAs
Deposits in SLAs are equal to 0.1% of deposits in banks
15
2
4
6
8
10
12
14
2
4
6
8
10
12
2009 2010 2011 2012 2013 2014
EURmillion
EURmillion
Deposits with banks and savings and loan associations
savings and loan associations (right scale) banks (left scale)

16. Prices for housing have increased significantly
faster than incomes since the second half of 2013
Sources: Estonian Land Board, Statistics Estonia
16
0.0
0.5
1.0
1.5
2.0
2.5
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Ratio of median price per square metre of an apartment to
average gross monthly wages
Tallinn Estonia

17. Housing prices have risen faster in bigger cities
and in the Tallinn districts with larger populations
Source: Estonian Land Board
80
90
100
110
120
130
140
150
160
170
180
2009 2010 2011 2012 2013
Real estate prices in largest Estonian towns
Q3 2009 = 100
Tartu Pärnu Narva
Kuressaare Tallinn
90
110
130
150
170
190
210
2009 2010 2011 2012 2013
Real estate prices in Tallinn districts
Q3 2009 = 100
Haabersti Kesklinn Lasnamäe
Mustamäe Põhja-Tallinn
17

18. Banks have a smaller role in the housing market than
during the boom
Sources: Estonian Land Board, Eesti Pank18
0%
20%
40%
60%
80%
100%
120%
140%
0
500
1,000
1,500
2,000
2,500
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
EURmillion
Volume of mortgage loans issued in the year and value of real estate
transactions for residential space
volume of new housing loans value of real estate transactions by private people
mortgage turnover / transaction value (right scale)

19. The banks have not run lending campaigns, which
would have boosted demand for housing further
Lending standards and conditions have not changed greatly
19
0%
1%
2%
3%
4%
5%
6%
7%
8% 2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Interest rate on new housing loans by components
6m EURIBOR interest margin

20. Main risks and conclusions

21. Risks to Estonian financial stability from the
external environment have increased
The main risks to Estonian financial stability
A worsening of risk assessments for Nordic economies and banks could increase the funding and liquidity
risks of parent banking groups
A deterioration in the external environment could worsen the outlook for economic growth in Estonia and
lower the loan quality of the banks
The rapid rise in Estonian real estate prices may affect the financial behaviour of households and companies
and lead risks to the financial system to build up
minor risk major risk
arrow indicates changes in the risk level from the previous assessment of October 2013
21

22. Any worsening of the risk assessment for the Nordic
countries will increase the funding and liquidity risks of
the parent banking groups
• The banks have largely funded the growth in household indebtedness using funds
from the financial markets. A funding model which is excessively based on market
confidence can be rather fragile
• As Nordic bank groups have over 90% of the Estonian banking market, and Swedish
banks have around 80%, then there would be a significant weakening of Estonian
financial stability if this risk were to be realised
– Realisation of this risk would damage the Estonian economy through external
trade links and the funding and liquidity risk to local banks that would come
through the banking groups
• The Swedish central bank and financial supervisory authority have tightened
requirements for liquidity and capital. Although this is necessary to ensure financial
stability, it may not have enough effect to prevent risks building up further
22

23. Any deterioration in the external environment
could damage the outlook for economic growth
in Estonia and worsen the loan quality of banks
• The Estonian economy is dependent on a recovery in external demand and on
confidence
– Wage pressure could restrict the competitiveness of companies in export
markets
– Events in Ukraine could raise uncertainty for Estonian companies and for
our main trading partners
• The banking sector has good buffers
– The direct exposures of the Estonian financial sector in Ukraine and Russia
are small and so the immediate systemic risk is limited
– The Estonian economy and banking sector are more resilient now to any
deterioration in the external environment than they were before the
Russian crisis in 1998 or the global financial crisis in 2008
23

24. The rapid rise in Estonian real estate prices could lead to
risky behaviour and a build-up of risks to the financial
system
• The build-up of risk comes from unreasonable expectations for real estate prices
and for the continuation of rapid wage growth
• There is a greater chance risks will be underestimated when interest rates are low
A cautious housing loan market is helping keep risks under control
• The role of the banks in financing residential real estate transactions is smaller than
in the past and lending conditions (interest margins and loan maturities) have not
been loosened
• Banks need to continue to follow responsible lending principles when assessing the
loan repayment ability of borrowers and requiring them to make sufficient down
payments
• Eesti Pank is prepared to impose requirements for stricter lending conditions if
necessary
24

25. Eesti Pank has been granted responsibility for
macroprudential supervision
• One week ago the Riigikogu changed the law to give Eesti Pank the right to act
as a macroprudential authority
• Eesti Pank has the right to set additional capital and liquidity requirements for
banks when necessary
– Banks in the European Union are subject to a single set of minimum
requirements, but additional capital and liquidity requirements can be
imposed in response to the condition of the local economy or financial
sector or the credit cycle
• Eesti Pank also has the right to set stricter requirements for lending standards,
such as limits on the loan to value ratio and the ratio of a borrower’s monthly
repayments and income
25

26. Capital requirements in Estonia from 2014
The systemic risk buffer requirement will come in under a decree of the Governor of Eesti Pank
Core Equity Tier 1 (CET1)
requirement
Total equity requirement
Base requirement 4.5% 8%
Buffer requirement
Systemic risk buffer 2%
Capital conservation buffer 2.5%
Counter-cyclical buffer 0%
Total capital requirement 9% 12.5%
26

27. The risks to the Estonian financial sector are small,
but have increased in the past six months
• Estonian financial stability is still supported by
– increased economic activity in the euro area
– market confidence in the Nordic countries
– the strengthened financial position of Estonian companies and
households, and the high capitalisation of the local banking sector
• Risks have increased since the autumn
– The conflict between Ukraine and Russia has increased uncertainty
about the external environment
– Real estate price rises have accelerated, which risks creating imbalances
in the Estonian economy
27

28. Risks to Estonian financial stability from the external
environment have increased
The main risks to Estonian financial stability
A worsening of risk assessments for Nordic economies and banks could increase the funding and liquidity
risks of parent banking groups
A deterioration in the external environment could worsen the outlook for economic growth in Estonia and
lower the loan quality of the banks
The rapid rise in Estonian real estate prices may affect the financial behaviour of households and companies
and lead risks to the financial system to build up
minor risk major risk
arrow indicates changes in the risk level from the previous assessment of October 2013
28